Worst-case Greece scenario is tolerable, so be bullish
- Despite optimism about a deal, the Greek crisis will eventually lead to losses
- The losses will be manageable, but could increase political risks
- European equity markets may be about to jump higher
By Juhani Huopainen
There is a whiff of optimism at the moment that the Greek crisis could be solved. Unfortunately looks can be deceiving. Solving the acute cash shortfall only amounts to kicking the can down the road rather than addressing and fixing the real problem.
Greece is not competitive, and this coupled with deep fiscal cuts and high output gap has guaranteed that the debt that was too high before the onset of the euro crisis, too high after both the first two bailouts, and too high after the sovereign debt restructuring of 2012 is still unsustainable.
The Greek government’s debt is now almost completely held by the official creditors. So restructuring it would cause real losses not to investors, but European taxpayers.
Sending cheques to yourself
There has been a pause in the final payments of the second bailout. Everyone knows that Greece needs a third bailout in order to be able to pay back its earlier bailout loans. The funds have gone largely to creditor country banks, which were the original creditors.
In essence, the creditor countries are complaining that they have bailed out their own banks, and now complain that they will have to recycle money – send it to Greece so Greece can send it back.
Sure, there are reasons to be angry at Greece because the country falsified its national accounts and its pace of reforms has been slow. But even the International Monetary Fund already admitted in 2013 that the original programme was flawed and too optimistic. In short, Greece never had a chance, and no-one is innocent.
Despite a possible kicking of the can now, eventually there will be losses for European taxpayers. The losses will be just as real, whether they come from voluntary debt forgiveness or an outright default by the Greeks. Possibly the creditor countries would prefer to push Greece into a default, so that they could put the blame for the losses solely on Greece.
Worst-case – losing everything, but tolerable
Let’s assume that the worst happens and Greece defaults completely on every possible item: the bilateral loans, the loans from the European Financial Stability Fund, the bonds held by the European Central Bank, Greece’s TARGET2 liabilities, including the Emergency Liquidity Assistance, which is provided by the Greece’s national central bank, and should be repaid to the ECB in case of a Grexit – but not necessarily would be repaid.
According to data from Bloomberg and Barclays, the Eurozone’s official exposure to Greece is roughly €330 billion, which equals 3.3% of the single currency area’s GDP. That sounds like a big deal, but let’s look at Eurozone debt and deficit levels first.
Eurozone government budget deficit was at post-crisis low of 2.4% in 2014. As Germany had a small surplus, the median deficit is higher. On average, the exposure to Greece is equivalent to the annual budget deficit of Eurozone member nations.
Chart source: Saxo Bank
The European Central Bank’s sovereign bond purchase programme has managed to push bond yields to low levels, even given the recent spike higher. All of the countries have market access. I don’t think Spain’s debt sustainability would be significantly worse if its debt-to-GDP rose from 98% to 101.7%, or in case of Netherlands, from 69% to 71.9%.
There will be no meltdown, because there are no private creditors left holding Greek bonds who could cause a Lehman Brothers-type chain reaction in the financial system.
Debt forgiveness would be a non-event both fiscally and in economic terms for the Eurozone. The political risks within the crisis and creditor countries are a different matter, especially in case of a default, which would probably force Greece to exit the monetary union. I will discuss these risks in my next article.
For now, note that the Germany's DAX index has just seen a 13% correction, which is about as much as it normally corrects to the downside. The daily chart (see below) shows a flag pattern. Flag patterns are continuation patterns within a longer trend, and are thought to lead to a resumption of the trend once the price breaks outside the pattern.
The index sits very close to the upper end of the flag at the moment, and could see an impulsive breakout soon.
Flag pattern in the DAX
Chart source: Saxo Trader. Create your own charts with SaxoTrader; click here to learn more.
– Edited by Robert Ryan
Juhani Huopainen is a blogger and a macro analyst at MoreLiver’s Daily. Follow Juhani or post your comment below to engage with Saxo Bank's social trading platform.